Supply and Demand: How Markets Work

  

Supply and

Demand:

How Markets

Work

  

Supply and

Demand:

How Markets

Work

  In this chapter you will… In this chapter you will…

• Learn the nature of a competitive market.

• • Examine what determines the demand for

  a good in a competitive market.

• • Examine what determines the supply of a

  good in a competitive market.

• • See how supply and demand together set

  the price of a good and the quantity sold.
• Consider the key role of prices in allocating scarce resources.
• Learn the nature of a competitive market.

• • Examine what determines the demand for

  a good in a competitive market.
• Examine what determines the supply of a good in a competitive market.

• • See how supply and demand together set

  the price of a good and the quantity sold.

• Consider the key role of prices in allocating scarce resources.

THE MARKET FORCES OF THE MARKET FORCES OF SUPPLY AND DEMAND SUPPLY AND DEMAND

• Supply

  

Supply and Demand are the two

words that economists use most

often.

• Supply
• Supply and Demand are the forces

• • Supply and Demand are the forces

  that make market economies work!

• Modern

• • Modern microeconomics is about

  supply, demand, and market equilibrium.

  Supply and Demand are the two

words that economists use most

often.

  that make market economies work!

  microeconomics is about supply, demand, and market equilibrium.

  

MARKETS AND COMPETITION

MARKETS AND COMPETITION

• The terms
• The terms supply and demand refer to the behaviour of people.
• .as they interact with one another in markets.
• A market
• .as they interact with one another in markets.
• A

  is a group of buyers and sellers of a particular good or service.

  supply and demand refer to the behaviour of people.

  market is a group of buyers and sellers of a particular good or service.

• – Buyers determine demand...
• – Sellers determine supply…<
• – Buyers determine demand...
• – Sellers determine supply…

  with many buyers and sellers so that each has a negligible impact on the market price.

  

Competitive Markets

Competitive Markets

  

Competitive Market is a market

with many buyers and sellers so that

each has a negligible impact on the

market price.

• A
• A Competitive Market is a market

  

Competition: Perfect or Otherwise

Competition: Perfect or Otherwise

   Perfectly Competitive:  Homogeneous Products  Buyers and Sellers are Price Takers  Monopoly:  One Seller, controls price

   Oligopoly:  Few Sellers, not aggressive competition

   Monopolistic Competition:  Many Sellers, differentiated products

   Perfectly Competitive:  Homogeneous Products  Buyers and Sellers are Price Takers

   Monopoly:  One Seller, controls price

   Oligopoly:  Few Sellers, not aggressive competition

   Monopolistic Competition:  Many Sellers, differentiated products

DEMAND DEMAND

• Quantity Demanded
• Quantity Demanded refers to the

  amount (quantity) of a good that

buyers are willing to purchase at

alternative prices for a given period.

   refers to the amount (quantity) of a good that buyers are willing to purchase at alternative prices for a given period.

  Determinants of Demand Determinants of Demand

• What factors determine how much ice

• • What factors determine how much ice

  cream you will buy?

• • What factors determine how much you

• • What factors determine how much you

  will really purchase? 1)

  Product’s Own Price 2)

  Consumer Income 3)

  Prices of Related Goods 4) Tastes 5) Expectations 6)

  Number of Consumers

  cream you will buy?

  will really purchase? 1)

  Product’s Own Price 2)

  Consumer Income 3)

  Prices of Related Goods 4) Tastes 5) Expectations 6)

  Number of Consumers

1) Price 1) Price

  Law of Demand

• – The law of demand states that,
• – The law of demand states that,

  other things equal, the quantity demanded of a good falls when

the price of the good rises.

  Law of Demand

  other things equal, the quantity demanded of a good falls when

the price of the good rises.

2) Income 2) Income

• As income increases the
• As income increases the

  demand for a normal good will increase.

• As income increases the
• As income increases the

  demand for an inferior good will decrease.

  

demand for a normal good will

increase.

  demand for an inferior good will decrease.

3) Prices of Related Goods 3) Prices of Related Goods Prices of Related Goods

• – When a fall in the price of one

• – When a fall in the price of one

  good reduces the demand for another good, the two goods are called substitutes.

• – When a fall in the price of one

• – When a fall in the price of one

  good increases the demand for another good, the two goods are Prices of Related Goods

  good reduces the demand for another good, the two goods are called substitutes .

  good increases the demand for another good, the two goods are

4) Others 4) Others

• Tastes
• Tastes>

  • Expectations

• • Expectations

  The Demand Schedule and the The Demand Schedule and the Demand Curve

Demand Curve

  

 The demand schedule is a table that

shows the relationship between the

price of the good and the quantity

demanded.

   The demand curve is a graph of the

relationship between the price of a

good and the quantity demanded.

  

 Ceteris Paribus: “Other thing being

 The demand schedule is a table that shows the relationship between the price of the good and the quantity demanded.

   The demand curve is a graph of the

relationship between the price of a

good and the quantity demanded.

   Ceteris Paribus : “Other thing being equal”

  

Table 4-1: Catherine’s Demand Schedule

Table 4-1: Catherine’s Demand Schedule

  Price of Ice-cream Quantity of cones Cone ($) Demanded

  0.00

  12

  0.50

  10

  1.00

  8

  1.50

  6

  2.00

  4

  2.50

  2

  3.00

  Figure 4-1: Catherine’s Demand Curve _{Cream Price of Ice-} Figure 4-1: Catherine’s Demand Curve

  Cone _$3.00

  2.50

  2.00

  1.50

  1.00

  0.50

  

Market Demand Schedule

Market Demand Schedule

• Market demand is the

• • Market demand is the sum of all individual

  demands at each possible price.

• • Graphically, individual demand curves are

• • Graphically, individual demand curves are

  summed horizontally to obtain the market demand curve.

• Assume the ice cream market has two
• Assume the ice cream market has two

  buyers as follows…

  sum of all individual demands at each possible price.

  summed horizontally to obtain the market demand curve.

  buyers as follows…

  3.00

  1.50

  16

  13

  10

  7

  4

  5

  4

  3

  2

  1.00

  8

  6

  10

  2.00

  4

  2.50

  2

  1

  7 Nicholas

  6

  1

  0.00 Catherine Price of Ice-cream Cone ($) Table 4-2: Market demand as the Sum of Table 4-2: Market demand as the Sum of Individual Demands Individual Demands +

  12

  0.50

  19 Market =

  Price of Ice- _{Cream Cone}

  D ₃ D ₁ D ^Increase ₂ ^{Decrease in demand in demand} Figure 4-3: Shifts in the Demand Curve Figure 4-3: Shifts in the Demand Curve

  

Table 4-3: The Determinants of Quantity

Table 4-3: The Determinants of Quantity

  Demanded Demanded

  Shifts in the Demand Curve Shifts in the Demand Curve versus versus

  

Movements Along the Demand Curve

Movements Along the Demand Curve

  

Figure 4-4 a): A Shifts in the Demand Curve

_{Price of}

Figure 4-4 a): A Shifts in the Demand Curve

  Cigarettes, _{per Pack. A policy to discourage}

_{curve to the left.}

  smoking shifts the demand _$2.00 B _A D ₁ D ₂

  Figure 4-4 b): A Movement Along the Figure 4-4 b): A Movement Along the Demand Curve _{Cigarettes, Price of} Demand Curve per Pack. _{C of cigarettes results in a A tax that raises the price} $4.00 _{demand curve. movements along the $2.00}

  A D ₁

SUPPLY SUPPLY

• Quantity Supplied
• Quantity Supplied refers to the

  amount (quantity) of a good that sellers are willing to make available

for sale at alternative prices for a

given period.

   refers to the amount (quantity) of a good that sellers are willing to make available for sale at alternative prices for a given period.

  Determinants of Supply

Determinants of Supply

• What factors determine how much

• • What factors determine how much

  ice cream you are willing to offer or produce? 1)

  Product’s Own Price 2)

  Input prices 3)

  Technology 4)

  Expectations 5)

  Number of sellers

  ice cream you are willing to offer or produce? 1)

  Product’s Own Price 2)

  Input prices 3)

  Technology 4)

  Expectations 5)

  Number of sellers

1) Price 1) Price

  Law of Supply

• – The law of supply states that,
• – The law of supply states that,

  other things equal, the quantity supplied of a good rises when the price of the good rises.

  Law of Supply

  other things equal, the quantity supplied of a good rises when the price of the good rises.

  The Supply Schedule and the The Supply Schedule and the Supply Curve Supply Curve

 The supply schedule is a table that

shows the relationship between the

price of the good and the quantity

supplied.

   The supply curve is a graph of the relationship between the price of a good and the quantity supplied.

  

 Ceteris Paribus: “Other thing being

 The supply schedule is a table that shows the relationship between the

price of the good and the quantity

supplied.

   The supply curve is a graph of the

relationship between the price of a

good and the quantity supplied.

   Ceteris Paribus : “Other thing being equal”

  Table 4-4: Ben’s Supply Schedule Table 4-4: Ben’s Supply Schedule Price of Ice-cream Quantity of cones Cone ($) Supplied

  0.00

  0.50

  1.00

  1

  1.50

  2

  2.00

  3

  2.50

  4

  3.00

  5

  Figure 4-5: Ben’s Supply Curve _{Cream Price of Ice-} Figure 4-5: Ben’s Supply Curve

  Cone _$3.00

  2.50

  2.00

  1.50

  1.00

  0.50

  

Market Supply Schedule

Market Supply Schedule

• Market supply is the

• • Market supply is the sum of all individual

  supplies at each possible price.

• • Graphically, individual supply curves are

• Graphically, individual supply curves are

  summed horizontally to obtain the market demand curve.

• Assume the ice cream market has two
• Assume the ice cream market has two

  suppliers as follows…

  sum of all individual supplies at each possible price.

  summed horizontally to obtain the market demand curve.

  suppliers as follows…

  Table 4-5: Market supply as the Sum of Table 4-5: Market supply as the Sum of Individual Supplies Individual Supplies Price of Ice-cream Ben Nicholas Market Cone ($)

  0.00

• + =

  0.50

  1.00

  1

  1

  1.50

  2

  2

  4

  2.00

  3

  4

  7

  2.50

  4

  6

  10

  3.00

  5

  8

  13

  Price of Ice- _{Cream Cone}

  

S

₃ S ₂ S ₁ Decrease _{in supply} Increase _{in supply}

  Figure 4-7: Shifts in the Supply Curve Figure 4-7: Shifts in the Supply Curve

  

Table 4-6: The Determinants of Quantity

Table 4-6: The Determinants of Quantity

  Supplied Supplied

SUPPLY AND DEMAND SUPPLY AND DEMAND TOGETHER TOGETHER

• Equilibrium refers to a situation in which

• • Equilibrium refers to a situation in which

  the price has reached the level where the price has reached the level where quantity supplied equals quantity quantity supplied equals quantity demanded. demanded.

  

Equilibrium

Equilibrium

• Equilibrium Price
• Equilibrium Price – The price that balances quantity supplied and quantity demanded.
• – The price that balances quantity supplied and quantity demanded.
• – On a graph, it is the price at which the supply and demand curves intersect.
• – On a graph, it is the price at which the supply and demand curves intersect.
• Equilibrium Quantity
• Equilibrium Quantity – The quantity supplied and the quantity demanded at the equilibrium price.
• – The quantity supplied and the quantity demanded at the equilibrium price.
• – On a graph it is the quantity at which the supply and demand curves intersect. <
• – On a graph it is the quantity at which the supply and demand curves intersect.

  At $2.00, the quantity demanded

Demand Schedule Supply Schedule

  

Equilibrium

Equilibrium Equilibrium price Demand ^{Supply $2.00 Equilibrium} _{Equilibrium quantity} ^{Price of Ice-Cream Cone}

  

Figure 4-8: The Equilibrium of Supply and

Figure 4-8: The Equilibrium of Supply and Demand Demand

  chasing too few goods, thereby moving toward

  

Equilibrium

Equilibrium

• Surplus
>Surplus – When price &gt; equilibrium price, then quantity supplied &gt; quantity demanded.
• There is excess supply or a surplus.
• Suppliers will lower the price to increase sales, thereby moving toward equilibrium.
• Shortage – When price &lt; equilibrium price, then quantity demanded &gt; the quantity supplied.
• There is excess demand or a shortage.
• Suppliers will raise the price due to too many buyers
  • – When price &gt; equilibrium price, then quantity supplied &gt; quantity demanded.

• There is excess supply or a surplus.
• Suppliers will lower the price to increase sales, thereby moving toward equilibrium.
• Shortage
• – When price &lt; equilibrium price, then quantity demanded &gt; the quantity supplied.
• There is excess demand or a shortage.
• Suppliers will raise the price due to too many buyers

  Demand ^{Supply $2.00}

  6 ^{8 Price of 10 Quantity of Ice- Ice-Cream Cone 4 2 1 3 5 7 9 11 $2.50 Surplus}

  Figure 4-9 a): Excess Supply Figure 4-9 a): Excess Supply

  Demand ^{Supply $2.00}

  6 ^{8 Price of 10 Quantity of Ice- Ice-Cream Cone 4 2 1 3 5 7 9 11 $1.50 Shortage}

  Figure 4-9 b): Excess Demand Figure 4-9 b): Excess Demand

  

Three Steps To Analyzing

Three Steps To Analyzing

  

Changes in Equilibrium

Changes in Equilibrium

• Decide whether the event shifts the supply or demand curve (or both).
• Decide whether the curve(s) shift(s) to the left or to the right.

• • Use the supply-and-demand diagram

  to see how the shift affects equilibrium price and quantity.

  to see how the shift affects equilibrium price and quantity.

  A Heat Wave

• Example:
• Example: A Heat Wave
• Decide whether the event shifts the supply or demand curve (or both).
• Decide whether the curve(s) shift(s) to the left or to the right.

• • Use the supply-and-demand diagram

  Figure 4-10: How an Increase Demand Figure 4-10: How an Increase Demand

  Affects the Equilibrium _{Ice-Cream Price of} Affects the Equilibrium _{Cone demand for ice cream…}

  1. Hot weather increases the _{Supply $2.50} New equilibrium _{2. … resulting in} $2.00 _{equilibrium Initial D 2 price …} a higher

  D _{1 1 2 3 4 5 6 7 10 11} Quantity of Ice-

  Figure 4-11: How a Decrease Demand Figure 4-11: How a Decrease Demand

  Affects the Equilibrium _{Ice-Cream Price of} Affects the Equilibrium _{S 2} Cone _{supply of ice cream… 1. An earthquake reduces the S 1 $2.50} New equilibrium _{2. … resulting in $2.00}

  Initial equilibrium _{price …} a higher Demand _{1 2 3 4 7 10 11} Quantity of Ice-

  D ₁ ^{S Ice-Cream 1 Price of Cone D P 2 Large increase in demand 2 S Initial equilibrium 2 New equilibrium Small decrease in supply P 1} Figure 4-12 a): A Shift in Both Supply and Figure 4-12 a): A Shift in Both Supply and

  Demand Demand

  D ₁ ^{S Ice-Cream 1 Price of Cone D P 2 Large decrease in supply 2 S Small increase}

²

^{New equilibrium in demand Initial equilibrium P 1} Figure 4-12 b): A Shift in Both Supply and Figure 4-12 b): A Shift in Both Supply and

  Demand Demand

  Table 4-8: What Happens to Price and Table 4-8: What Happens to Price and

Quantity when Supply or Demand Shifts

  

Quantity when Supply or Demand Shifts

  Concluding Remarks… Concluding Remarks…

• Market economies harness the

  forces of supply and demand. . .

• Supply and Demand together

  determine the prices of the

economy’s different goods and

services. . .

  determine the prices of the

economy’s different goods and

services. . .

• • Prices in turn are the signals that

  guide the allocation of resources.

• • Prices in turn are the signals that

  guide the allocation of resources.
• Market economies harness the

  forces of supply and demand. . .

• Supply and Demand together

  buyers and sellers, each of whom has little or no influence on the market price.

  Summary Summary

• Economists use the model of supply and demand to analyze competitive markets.
• In a competitive market, there are many
• Economists use the model of supply and

  demand to analyze competitive markets.

• In a competitive market, there are many

  buyers and sellers, each of whom has little or no influence on the market price.

  Summary Summary

• The demand curve shows how the
• The demand curve shows how the

  quantity of a good depends upon the price.

• – According to the law of demand, as the price of a good falls, the quantity demanded rises.
• – According to the law of demand, as the price of a good falls, the quantity demanded rises.

  Therefore, the demand curve slopes downward.

• – In addition to price, other determinants of how
• – In addition to price, other determinants of how

  much consumers want to buy include income, the prices of complements and substitutes, tastes, expectations, and the number of buyers.

  quantity of a good depends upon the price.

  Therefore, the demand curve slopes downward.

  much consumers want to buy include income, the prices of complements and substitutes, tastes, expectations, and the number of buyers.

  Summary Summary

• The supply curve shows how the quantity of a good supplied depends upon the price.
• The supply curve shows how the quantity of a good supplied depends upon the price.
• – According to the law of supply, as the price of

  a good rises, the quantity supplied rises.

• – According to the law of supply, as the price of

  a good rises, the quantity supplied rises.

  Therefore, the supply curve slopes upward.

  Therefore, the supply curve slopes upward.

• – In addition to price, other determinants of how
• – In addition to price, other determinants of how

  much producers want to sell include input

prices, technology, expectations, and the

number of sellers.

  

much producers want to sell include input

prices, technology, expectations, and the

number of sellers.

• – If one of these factors changes, the supply curve shifts.

• – If one of these factors changes, the supply

  curve shifts.

  Summary Summary

• • Market equilibrium is determined by the

• • Market equilibrium is determined by the

  intersection of the supply and demand curves.

• At the equilibrium price, the quantity demanded equals the quantity supplied.
• The behavior of buyers and sellers
• At the equilibrium price, the quantity demanded equals the quantity supplied.
• The behavior of buyers and sellers

  

naturally drives markets toward their

equilibrium.

  

intersection of the supply and demand

curves.

  naturally drives markets toward their equilibrium.

  

The End

The End